Will the West be Picking Up Ukraine's Gazprom Tab?

Michael Teague  |

With stocks trading to robust gains over the past two sessions, it would appear that the crisis in Ukraine that has had investors in a state of panic at various junctures over the past few weeks has more or less fallen off the radar.

But the turmoil in Eastern Europe continues apace. After Russia officialized its annexation of Crimea on March 21, the US and its European allies successfully pushed for Russia's suspension from the "Group of 8 (G8)" industrial nations. This was accompanied by another flurry of heated rhetoric from the newly-christened G7 vowing that the next round of sanctions would be designed to target key sectors of the Russian economy rather than a handful of individuals who are allegedly part of President Vladimir Putin’s inner circle.

Ukraine's outstanding balance

On Tuesday however, investors in the US seemed not to notice what could be the newest flashpoint in the conflict, after Russia’s natural gas producing behemoth Gazprom announced that it would be increasing the price of exports to Ukraine by a whopping 40 percent.

Despite a prior agreement signed last December had set prices at $268.5 per 1,000 cubic meters, Gazprom’s move on Tuesday hiked that figure substantially higher to, $385.5 per 1,000 cubic meters, much more than what Gazprom even charges its Western European clients.

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The company’s CEO Alexei Miller explained the price hike by citing Ukraine’s $1.7 billion outstanding balance which had previously been a matter of dispute. Indeed, in 2009, Ukraine’s gas supply was entirely cut off by Gazprom for a period of weeks while the two argued over the same issue. In that instance, however, Western Europe was made to suffer as well, and during a particularly brutal winter.

Not many alternatives

The Ukraine currently depends on its Russian neighbor for half of its energy supply, an amount that it will be difficult to replace from other sources in the short-term. The problem is further compounded by the fact that even prior to the events that lead to the overthrow of Russian-backed President Viktor Yanukovich, Ukraine’s financial situation was in a dismal state.

In the wake of recent events, the International Monetary Fund has put together up to $18 billion in standby credit for Ukraine, conditional upon its enactment of the usual harsh austerity measures that accompany this type of aid. The extended credit makes up the majority of a larger $27 billion international aid package, the $3 billion of which is set to arrive by the end of March.

Thus, while Russia’s major energy producers that include not only Gazprom but also Chernomorneftegaz, and Naftogaz, have been busy with proposals to develop Crimea’s oil and gas sector in order to greatly increase output from the region.

To which country should Gazprom adress Ukraine's bill?

In the unlikely event that Ukraine decides to pay off its balance with Gazprom up front and in full the very moment the aid money shows up, it will still need to purchase a large portion of its energy from Russian producers, at least for the foreseeable future, and will thus be to some extent at their mercy.

And as President Barack Obama and his European allies decide what sanctions, if any, to move ahead with in the coming weeks and months, there will no doubt be at least some consternation at the fact that their financial contributions to Ukraine’s new government will end ultimately find its way into Russian coffers.

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